Beware of market complacency
There is an eerie quiet around markets currently; intraday equities moves are trending back to the value average mean price (VWAP) and currencies are treading water suggesting that fair value is globally priced in, barring the moves seen in the EUR.
But the development that is likely to filter into the currency markets in the next week or two, and equities over the coming months, is bond price movements and the VIX index moves.
US treasuries fell to their lowest yield reading in 11 months on Friday night, risk-off is picking up and nerves are being tested. But the interesting development around risk-off trading is that volatility complacency has crept into peoples' trading over the past 14 months.
Put protection has dropped to its lowest level since 2007 as the 200-day moving average of the VIX hits 14.3, down from last year's average 14.9. Considering the 30% plus move in the S&P last year and the euphoric pick up in equities as the Fed continued to pump funds into the markets, put protection seemed a non-issue as funds have flowed into the return on capital trade showing why the high price momentum trade has been so lucrative.
What will be interesting is come October when the Fed is full out of the market on wrapping up its asset purchase program - will the safety net trade rapidly pick up? The tick up in the VIX index as protection starts to be implemented suggests investors are starting to get a little nervous about the pace and recovery of the market post the Fed's exit. The question then becomes is the markets longer term rally going to abate?
According to Credit Suisse if you look at the length of all bull markets back to 1949 the average length of the rally is on a medium basis 1826 days on a mean basis 1955.
If that is the case then the current bull rally in the US is due to finish in either July 2014 on medium basis or in March 2015 on mean basis; considering the breakdown in the charts at the finish of each QE programs I think the bull rally could come to an end in the middle of these to calls that would suggest November as the start of a stronger than usual pullback as growth remains below trend and hot money slows.
This is why I am currently neutral on equity markets, the trend hasn't been broken yet and I want to remain with the trend, however I am acutely aware that on a macro thematic there are certainly hurdles coming in the current bull market rally. If the trend breaks down like the macro theme suggests, I would want to be ready for that change.
Ahead of the Australian Open
Based on the Saturday night close of the futures market we are currently calling the Aussie market up 15 points to 5484 on the 10am bell (AEST) and will be watching NAB, Westpac and ANZ as invests look to pick up defensive plays having turned ex-dividend. The yield trade is one that will be maintained now with bond yields falling off and rate on hold.
I believe the risk around yield hunters cashing out on the initiation of a rate hike is assured but the RBA has made it clear that is unlikely to happen this year and the low yield in bonds should make them attractive once more in the short term.
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